Penny Pinchers: Our Sixth Annual SG&A Survey

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Let’s face it. In the seventh year of the strongest bull market since World War II, the subject of cost savings is generally less riveting than, say, the size of the latest mega-merger. So it is perhaps not surprising that, with few exceptions, CFO magazine’s sixth annual SG&A survey reveals little progress in the battle to lower selling, general, and administrative costs.

Overall, in fact, it’s a losing battle, to judge by average SG&A in the three years used to compute the current survey. More progress seemed likely four years ago, when the clamor for reengineering was nearly deafening.

Modest backsliding prevails, according to results compiled by Arthur Andersen LLP. The companies studies this year increased SG&A as a percentage of sales by 30 basis points, to 16.4 percent of sales, or $702.7 billion. All told, the increase in SG&A-to-sales swallowed nearly $13 billion. Sound slim? Had companies shed 30 basis points instead, they would have shipped roughly $17 billion to their collective bottom line, after taxes. That’s worth fighting for. “Is there a correlation between the ability to drive market share and the ability to drive down costs?” asks Dell Computer CFO Thomas Meredith. “Unequivocally, yes.”

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As in the other SG&A surveys, we singled out companies that appear to be winning the good fight. Big winners had to meet three criteria: they had to be the leanest in their industries in SG&A; their overall cost structure, encompassing SG&A and cost of goods sold (COGS), must have declined from year-end 1995 through year-end 1998; and this decline must have outpaced that of their competitors. Dell, for example, lowered SG&A by 143 basis points and COGS by 236 basis points over three years, or 370 basis points in total. The competition, as a group, added 78 basis points to cost structure. Dell’s edge, 457 basis points, helps explain its superlative earnings performance.

Whatever the industry, leaders share certain propensities. Take Sonic Automotive, for instance. “If you could see my office, you would see our attention to costs,” says Sonic CFO Theo Wright. He proudly occupies a small, sparsely furnished interior office on the mezzanine floor of a car dealership, one of 100 outlets that constitute the Charlotte, North Carolina, company. Over the three years covered in the survey, Sonic posted an average SG&A-to-sales of 9.11 percent, versus the industry average, 13.24 percent. Moreover, Sonic stayed just about even in three-year average cost-to-sales, down 1 basis point, while the industry added 180 basis points to average cost structure.

Compensation plans are tied to overall profit margins, Wright says. General managers of each dealership are paid a percentage of profits, and they receive additional compensation for annual increases to profitability. As business grows, Sonic sets higher profitability measures. Sonic watches SG&A closely and in great detail. Every dealership knows where it stands by expense category, and how it stacks up against other dealerships that Sonic operates. Because Sonic owns Ford dealers, General Motors dealers, and DaimlerChrysler dealers, managers on each site routinely compare their cost management with dealers of like vehicles. But Wright warns against draconian cost-cutting. “Our objective is not to minimize SG&A,” he says, “but to increase profitability.”

It’s a motivator shared by many of the top SG&A performers. “When you have very narrow margins,” says CFO Jerry Walton, of Lowell, Arkansas, truck operator J.B. Hunt, “pennies count.” There are 60,000 truckers in the United States willing to haul freight, and competition is fierce. Without a 5 percent margin overall, says Walton, a trucking company cannot afford to replenish its assets. “Every member of management, all our operating people, and most salaried employees are paid a bonus based on the operating ratio,” Walton says.

To compute its operating ratio, J.B. Hunt divides all expenses other than interest and taxes by revenues. Expense budgets are set each year on a monthly basis, and one member of the staff assumes responsibility for each specific expense category. Besides encouraging operating managers to keep tight lids on the expenses they oversee, the arrangement creates incentives to work as a team toward lowering costs. If office supplies are lean, for instance, but travel and entertainment gets out of hand, all bonuses are affected.

BJ’s Wholesale Club Inc. also marches to the beat of narrow margins. The Natick, Massachusetts-based food retailer beat the average reduction in costs of sales by 41 basis points. “We have to have the lowest expense structure or else our business model doesn’t work,” declares BJ’s CFO Frank Forward. Because BJ’s competes largely on price, gross profit margins are well below supermarket standards — about 12 percent versus 25 percent.

Like his counterparts in other low-margin businesses, Forward pays close attention to detail. “We have to watch pennies,” he says. Besides keeping close tabs on existing stores, Forward tracks SG&A to such a degree that BJ’s can project precisely the SG&A costs a new store location will generate. All told, BJ’s has chalked up eight consecutive years of operating-income improvement, Forward says, in no small part due to tight cost controls on every transaction with vendors, with customers, and internally.

For BJ’s, it’s just as important to manage costs of goods on the way in as on the way out. This is generally true, of course, but BJ’s has nudged technology to its limit, including using a 360-degree scanner that finds the bar coding anywhere on the surface of a package. The company also relies on so- called positive receiving, a system that scans deliveries that arrive as shelf space opens up. The result: lower handling costs. Instead of moving goods twice, from loading dock to storage, and then from storage to retail space, most goods are moved only once — from trucks to shelves. Scanning goods into stores and scanning them out at checkout counters also helps BJ’s keep precise tabs on traffic levels, so that the number of workers at any time reflects the number of customers. This efficiency helps keep payroll costs and resulting SG&A as trim as possible.

At Harte-Hanks Inc., a global provider of direct marketing services, in San Antonio, the legacy of a leveraged buyout in 1984 still keeps pressure on costs, according to CFO Jacques Kerrest. “The business model forces us to control the business at detailed levels,” says Kerrest. Corporate strategy calls for increasing operating income at a faster pace than sales growth. This makes SG&A and cost of goods sold high priorities.

Toward this end, Kerrest reviews the SG&A budget each month with finance executives in each of 20 business units. “Reviewing every month is the best way to teach [the merits of low SG&A],” Kerrest says. He insists, however, that flexibility is crucial. “You can’t really ask people that grow the business rapidly [to restrain SG&A]. They have to reinvest.”

Of Costs and Complexity

Like most other companies, Sonic Automotive carefully weighs the benefits of streamlining and simplifying businesses against the virtues of complexity. Each dealership is a complex business in its own right, consisting of a used-car sales business, a parts business, a service business, a finance business, an insurance business, and a rental business. “Because of complexity,” Wright says, “there are limits on our ability to reduce costs.”

J.B. Hunt also juggles the merits of complexity versus simplicity. Much as stripping complexity from the business appeals to cost-cutters, it’s not always a wise direction. “We are a marketing-oriented, customer-oriented business, and that makes our business much more complex,” CFO Walton concedes. J.B. Hunt operates a transportation and logistics business with margins in the 2 to 3 percent range, despite its need for a 5 percent minimum margin. Why? A trucking business gets the most lucrative returns by filling trucks, driving them a thousand miles, then filling them again and driving back. But a company with thousands of trucks can’t depend on serendipity to provide the cargo. The transportation and logistics business enables J.B. Hunt to compete for large shipments by customers like Procter & Gamble. “If P&G wants to move $80 million of freight, we can’t just cherry-pick what we want.”

Companies are made up of thousands, perhaps millions, of complex interactions that managers routinely ignore. Taken together, these multiple sources of complexities add costs and undermine efficiency. This could explain why SG&A costs seem so intractable year after year. In good times, they seldom seem worth managing, despite aggregate consequences to the bottom line. Absent a systematic way to identify and yank out these costs, efforts to manage them sap managers’ energy and time — not always a worthwhile trade- off. Yet these are the costs that can eventually choke a company’s ability to compete in a world that demands efficiency.

Enter complexity management, with its roots in activity-based management techniques. “Complexity management is not the answer to all ills, but it often provides critical insights into the rise of many SG&A costs,” says Pierre Guillaume, service manager at Arthur Andersen. But where activity-based management focused initially on manufacturing, especially the shop floor, its newer incarnation attacks costs embedded in every transaction, regardless of industry, from purchase orders for raw materials to handling customer service.

Costs creep back, says Guillaume, because companies cut costs, but fail to address underlying reasons for them. “Eliminating work that goes with costs,” he says, “is what complexity management is all about.”